The liability associated with a company’s defined benefit pension has always been hard to measure and, as a result, controversial. Companies in the private sector in the United States were forced to “bite the bullet” on this issue many years ago—in fact, it was in 1985 when Ronald W. Reagan was president.
A similar liability that is hard to measure and controversial is the liability for promised other postemployment benefits such as health care, provided by a company to its retirees. The U.S. private sector dealt with that accounting issue in 1990.
What about a U.S. state or local government entity that promises such benefits to its employees? Government entities have been following different accounting principles, but that will be changing soon for most them, at least when they are accounting for their defined benefit pensions, and possibly also when they are accounting for other postemployment benefits.
Background—Two Different Standard-Setters
Accounting principles that are used by private sector companies in the United States are those issued by the Financial Accounting Standards Board (FASB). Located in the same physical offices in Norwalk, Connecticut, is the Governmental Accounting Standards Board (GASB) that establishes the accounting principles for use by public sector entities—specifically, state and local governments, which may include cities, counties, school districts, libraries, fire departments, police forces, etc.
Private sector accounting principles are developed to assist financial statement users such as company managers, lenders, and stockholders evaluate how a company is performing from a financial standpoint. State and local governments have similar stakeholders, but, instead of stockholders, taxpayers that support the financial operations of the governmental entity are key.
Background—Different Methods and Their Consequences
What is so difficult about the accounting for defined benefit pensions and other postemployment benefit costs? In short, estimates, estimates, and more estimates. You have to estimate how long a person will live, the expected performance of any investments in the plan(s), projected inflation rates (inflation is a key variable for retiree health care benefits), and so forth. Accountants and management must rely heavily on the expertise of actuaries when developing these estimates.
Partially as a result of the rules the FASB issued in 1985, many companies changed from a defined benefit pension plan to a defined contribution plan (e.g., by using 401k plans). The accounting for a typical defined contribution plan is significantly easier because the level of complexity is reduced and fewer estimates are required. For example, when a company promises to contribute X% of a person’s salary to a separate plan, that is a fairly easy calculation. The greatest complexity arises around the question of what to do with forfeitures of such allocations should an employee quit before earning the benefit.
Similarly, after 1990, many private sector companies changed (or eliminated) benefits promised to their employees, because the companies had to accrue retiree health care benefits while employees still worked. The “pay-as-you-go” accounting that many employers used before the 1990 accounting rule change was no longer permitted.
Sound accounting theory provides that financial statement users should be informed about the cost of an employee while the employee is working for the company—not just when he or she is retired and sitting at home or playing golf.
What the GASB Has Now Changed
In August 2012, the GASB issued two standards approved in June covering pensions—GASB Statement No. 67, Financial Reporting for Pension Plans, and GASB Statement No. 68, Accounting and Financial Reporting for Pensions. Statement 67 addresses the accounting within the pension plan itself whereas Statement 68 addresses the accounting by the state and local governments that provide such benefits. Compliance with these standards will be required beginning in mid-2013 and mid-2014, respectively, as detailed below.
The guidance contained in these new pronouncements will change how governments calculate and report the costs and obligations associated with pensions in important ways. To quote the GASB, “[i]t is designed to improve the decision-usefulness of reported pension information and to increase the transparency, consistency, and comparability of pension information across governments.” (1)
Under existing accounting principles for state and local entities, governments have typically recorded their pension expense based on the actuarially determined annual required contribution (ARC), adjusted to reflect interest on actual contributions that are different than the ARC. Certain funding shortfalls as well as benefit changes, returns, etc. are being amortized over periods up to 30 years.
To say that issuance of these new standards was without controversy is far from true. The extensive due diligence requirements that the GASB has to follow when proposing changes generated a whopping 651 comment letters on the proposals, and they were mostly negative. The negative comment letters came from local governments that complained about complexity and stressing of their existing accounting resources; from members of the U.S. Congress effectively arguing “the system ain’t broke, don’t fix it;” from unions seeing promised benefits made more visible and therefore possibly jeopardized; and from other concerned parties.
That said, large accounting firms, actuaries, and CPA associations saw the changes as generally necessary to make financial reporting by entities affected by new GASB standards more meaningful and more consistent with financial reporting by private sector companies.
The provisions in Statement 67 are effective for financial statements for fiscal years beginning after June 15, 2013. The provisions in Statement 68 are effective for fiscal years beginning after June 15, 2014. Earlier application is encouraged for both statements. (2)
GASB Proposal for Other Postemployment Benefits
The GASB has not finalized its views on the accounting for other postemployment benefits such as retiree health care. Currently, the GASB plans to issue its required exposure draft of such proposed rules in the fall of 2013, and a final standard in the summer of 2014, after it consider the views in comment letters from constituents.
Summary Observations
Users of financial statements pressured the FASB nearly 20 years ago to “fix” how companies report pensions and other postemployment benefit (OPEB) plans. While private-sector financial statement users now benefit from better transparency of reported results, management and in particular human resource departments now must be more accountable for their decisions regarding employee benefits.
The new GASB standards will require significant implementation effort by the accounting, finance, and human resources departments of state and local governments, as was the case for those departments in the private sector when the FASB issued its new standards.
A key question remains as to how taxpayers and politicians, who effectively control the purse strings of local governments, will react to the new information being presented.
1 GASB Plain-Language Article, “New GASB Pension Statements to Bring about Major Improvements in Financial Reporting,” June 2012; available on the GASB website www.gasb.org.
2 The GASB states that the new standards “apply specifically to governments and pension plans in which a government’s contributions to the trust used to administer a pension plan are (a) irrevocable, (b) restricted to paying pension benefits, and (c) are beyond the reach of creditors. Pension benefits provided through trusts that do not meet those three criteria are not addressed in these new Statements ….” Ibid.
About the Author
Ron Pippin is an experienced CPA based in Wheaton, IL. His 40 plus year career includes being an audit partner in Arthur Andersen, a member of Andersen’s Professional Standards Group (“national office”) in Chicago, the Director of Financial Reporting for a Fortune 50 company and most recently, the editorial director of CCH’s Accounting Research Manager. Currently, Ron does independent writing and analysis as well as accounting consultation on a variety of topics.